Reforms (2014-19) for Employment and Empowerment

Introduction

        What will the Indian Economy look like in 2020? The answer will depend on whether the next Prime Minister (PM) and Finance Minister (FM) understand what has gone wrong in the last 4 years.  In particular, it will depend on whether the leader of the house and PM understands the importance of putting the Indian Economy back on the path of sustained fast growth for providing productive Employment and job opportunities for all (particularly the youth). The speed with which India is put back on the fast growth track will also depend on the professional quality and credibility of the person appointed as Finance Minister.  A reversal of the governance failures and regressive tax changes during 2010-13 will help recovery in 2014-15.  Much more will need to be done to put the economy back on track of Welfare catch up with the World and sustained growth in an a weak un uncertain Global environment.

Closing Welfare Gap

The welfare of the average Indian had increased to about a third (1/3^rd) of that of the average World inhabitant by 2010 and has stagnated since then. It is very important to understand that it is this gap between our per capita GDP (at PPP) and the World average, which results in our higher poverty ratios and is the main reason for the gap between our social welfare indicators and those of better-off countries(with a few exceptions). The fundamental objective of any Indian government must be to close the welfare gap of the Indian people with the rest of the World.  The next Indian government should aim to raise the per capita GDP level of India to 45% of global average by 2020. This requires a restoration of per capita growth to 6.5% (8% GDP) and a sustaining of this growth rate till 2020. This will generate economic opportunities and jobs for youth and begin to restore the welfare and dignity of the average Indian to the level of the average World inhabitant.

Setback

     During 1981 to 1991 the Indian economy grew in real terms at 2.1 per cent points above the average growth of the World economy.  The rate of growth of the Indian economy accelerated during 1992 to 2010 to 3.6 per cent points above the average growth of the World economy, because of the 1990s reforms. Since then, the real growth differential has collapsed to 1.2 per cent point.  The entire 2.4 per cent point drop in the growth differential can be attributed to domestic causes.  There are two broad reasons: One, deteriorating economic governance, including poor macro-economic management and the re-introduction of regressive rules, procedures and administrative practices (a la LPQ raj). Two, failure to introduce policy, regulatory and institutional reforms essential for sustaining  growth at the underlying growth potential of 8%.

Reviving Growth: Governance

        The next PMs top priority for his first two years in office must therefore be to restore the Indian economy to its long term growth potential of 8%+ (about 6.5% in per capita GDP terms) and to communicate the importance of this objective credibly to voters and the investment community.  An important determinant of credibility will be the Finance Minister selected by the PM to restore growth.  In a global environment marked by great uncertainty and risk, the FM must have the respect of the investor-investment community. This will ensure that the government’s program to restore growth gains immediate credibility.

   An improvement in day to day governance in terms of resolution of interdepartmental differences and speed of decision making within departments will help revive growth.  Three legislative mistakes, however, need to be corrected:

(a) Right to Education Act: Research has shown that the private non-profit sector provides education, of average quality equal to that of the public sector, at 1/3^rd the cost. By requiring the NPOs to double or triple the salaries of teachers it will drive them out & do incalculable damage to the cause of education. These clauses need to be dropped.

(b) Right to Food Act: By ignoring the corruption in the PDS-FCI while expanding the provision of cereals to 2/3^rd of the population, it does great dis-service to the hungry (1-3% of population) and to  wasted/ stunted/ “malnourished” children under 5 (7.5% of population).  The coverage of FSA should be scaled back to the 22% below poverty line (BPL) population and directed to eliminating hunger by seeking  them out in remote areas and identifying those hidden among the poor.  Govt. focus should be on eliminating the causes of child stunting-wasting, by improving sewage and sanitation and eliminating open defecation.[i]

(c) Land Acquisition Relief and Rehabilitation Act. The extremely laudable objective of fairness in compulsory acquisition of land has been converted into an expansive ecological and social agenda. Purely private voluntary land transactions must be removed completely from the ambit of this law and the enormous bureaucratization of rules and procedures rolled back.

Reforms for Sustaining Growth

    Among the reforms that can restore growth to 8 per cent and sustain it at that level over decades are:

 (1) Macro Pivot:[ii] Scale back government consumption expenditures including subsidies and transfers, to bring Revenue and Fiscal deficits to zero in five years. This will reduce government debt, the Current account deficit and foreign indebtedness and raise the national saving rate, allowing RBI to ease monetary policy and stimulate investment and consumer durable demand without fear of increasing Non Performing Assets or inflation.

(2) Agricultural Reform: [iii]  Halt procurement price led inflation and massive overstocking of wheat and rice, repeal Agricultural Produce Marketing Act and Essential Commodities Act. Remove all restrictions on FDI in food retail.  Replace the policy of Ad hoc agricultural import-export bans by import-export tariff bands that offer transparent protection within limits. These & related reforms will reduce Indian food inflation to the much lower levels prevailing globally, and thus help control overall inflation.

(3) Infrastructure: Break up government monopoly in coal and infrastructure sectors, namely railway, ports, airports, electricity distribution and transmission (open access), convert into publicly owned Ltd companies and set up a professional independent regulatory structure to oversee free entry & benchmark competition in these sectors.  This will set of a cycle of self-sustaining infrastructure growth and productivity improvement.

 (4) Sell all Public sector units in industry and finance that are inherently competitive (steel, airlines, power/ railway equipment, hotels, machinery; banks, insurance). [iv]  Use the proceeds to reduce national debt. This will stimulate a surge in manufacturing productivity (as in 1990s).

(5) Repeal exit clauses in labor laws with existing employees grand fathered. Allow private competition in Employee State insurance (ESI), Employee Provident Fund (EPF) and other monopoly social schemes for employees.

(6) Empower the poor (including farmers) through a UID linked Multi application smart card containing all entitlements (food, education, health etc).[v]

(7) Focus Plan programs on five basic public goods & services, essential for bringing the entire country into the 21^st century.[vi] (a) A quality National Road grid connecting every city and every village.  Highways/roads are the most cost effective stimulators of economic development. Roads & footpaths within cities and towns must be of quality expected of a middle income country. (b) A modern drainage, water supply & sewage system with water works, sewage treatment plants and comprehensive system for garbage disposal. In villages & habitations septic tanks and dry disposal devices would need to be implemented. Research shows that this will dramatically reduce disease and “malnutrition”. (c) Basic education (reading, writing & arithmetic) and Job skills (1/4500 recognized/certified) for every youth in this country. This will ensure that the rural & semi-urban youth are empowered to participate in a growing economy.  (d) Telecom (internet) connectivity for e-governance, public education, public health, development knowledge (agro/rural) and mobile banking to every habitation.  (e) Water & drainage Grid: Water planning, recycling, training and management for sustainable water use.

(8) Initiate fundamental political/electoral, police, judicial, legal and bureaucratic reform to address the issue of pervasive, systemic corruption and start restoring good governance.[vii]  Public safety & security is the right of all citizens as is “equality before law.” In the long term, “The rule of law” is critical to sustaining growth in a democratic open society. With good governance, we can even dream of welfare catch up with China!

Conclusion

       Such a program of reforms can sustain Indian GDP growth at over 8% (6.5% - 7% per capita growth) for the next two decades creating opportunities for youth and the emerging/new middle class, despite slower growth of World GDP and International Trade. It is not necessary to accomplish all the listed reforms within 2-3 years, though it may be opportune to take the politically sensitive steps within the first two years.  It is however essential to outline the broad direction of reforms and to take credible steps to implement them.

       A version of this article appeared in the Deccan Chronicle under the heading, "Next PM must have Ear for Reforms", ( http://www.deccanchronicle.com/131229/commentary-sunday-chronicle/article/next-pm-must-have-ear-reforms) and the Asian Age (http://www.asianage.com/cover-story/ear-reforms-next-pm-must-have-335 ) on December 29, 2013.

      A more detailed policy paper, "Reform Agenda for Growth and Welfare," Policy Paper No. 1/2014, New Delhi, January 2014 is at,  https://sites.google.com/site/drarvindvirmani/policy-papers .

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[i] Virmani, Arvind, "Undernurishment of Children: Causes of Cross-country Variation," Working paper No.WsWp 4/2012, October 2012. https://sites.google.com/site/drarvindvirmani/working-papers and Virmani, Arvind, “The Sudoku of Growth, Poverty and Malnutrition: Lessons For Lagging States,” Working Paper No. 2/2007-PC, Planning Commission, July  2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm .

[ii] http://dravirmani.blogspot.in/2013/02/macro-pivot-rebalancing-of-indian.html

[iii] See Agriculture reform at https://sites.google.com/site/chintan1997reg/economic-policy-and-regulation/agriculture. 

[iv] For rationale, see https://sites.google.com/site/chintan1997reg/institutional-reform/governance-corruption

[v] See http://dravirmani.blogspot.in/2012/12/the-unique-identification-uid-number.html

[vi] See Five point Program at,  https://sites.google.com/site/chintan1997reg/social-welfare/5pt-program .

[vii] See institutional reforms at, https://sites.google.com/site/chintan1997reg/institutional-reform

Tentative Rollback of License-Permit-Quota (LPQ) Raj: Indira 2-Rajiv

Introduction

     An earlier article, "Nehru-Indira Socialist Economics Failed," showed that the welfare of the average Indian declined relative to that of the average citizen of the world between 1950 and 1980.  Towards the end of the 1970s a number of analysts began to realize that the Socialist ideological – Statist - Bureaucratic approach to economic policy was leaving India further behind the dynamic developing countries.  The Janata Party was in the forefront of efforts to reverse the most egregious features of this regime, but it could not change much because of political instability within its ranks. Mrs. Indira Gandhi had three years, post 1977 election defeat to hear newly emboldened critics of her economic policy failures.  When she returned to Power in January 1980, she started reversing some of the most oppressive controls she had instituted, controls never seen before or since in a non-communist country. The rollback of the LPQ raj was continued by Rajiv Gandhi, who succeeded her on her death in 1984. V P Singh became PM after the 1989 elections and Chander Shekhar who succeeded him, were more like book ends to this phase of Economic development, given the political turmoil and dissensions unleashed by them. The roll back of the Nehru-Indira1 LPQ raj by Indira2–Rajiv resulted in an acceleration of the rate of growth of India’s per capita rate GDP during 1980 to 1991 and began the Welfare catch-up of India with the rest of the World.

 Welfare Catch-Up

     The World Data Indicators, the standard series of data for World economy has data on Per capita GDP at purchasing power parity from 1980.  It is therefore the preferred source for comparing Welfare relative to the rest of the World from 1980 onwards.  According to this source India’s per capita GDP at PPP was 0.15 of world average in 1980 and had increased to 0.18 of the World average by 1991. In other words the Welfare of the average Indian, improved by 19.3% relative to that of the average World inhabitant between 1980 and 1991.  17.2% points or 9/10^th of this improvement came during the Indira 2- Rajiv regime.

   The average per capita growth rate of GDP in India during 1980 to 1991 was 3.0% per annum compared to an average per capita growth rate of 1.1% per annum for the World.  Thus India’s per capita GDP grew an average 1.9% faster than the World economy during this period.  This was almost a complete reversal of the relative per capita growth rates in the previous two decades.  Though the average Indian was still pathetically poor relative to the average world inhabitant in 1991, the process of “welfare catch-up” with the rest of the World had finally begun.

Tentative Change

   At the end of the 1970s every aspect of production, pricing, investment, import and export was controlled by the Central Government. In the 1980s only the most glaring distortions were corrected. The scope for diversification (production of related items) and expansion of capacity for the industries under investment licensing (up to 25% above licensed from 0) was expanded. The definition of small-scale industry (SSI) was raised by increasing the size limit (value of output/sales) abd 40 industries de-reserved. The cement and aluminum industries, and others with assets below 5 (15) crore de-licensed in in 1985(1988) subject to conditions. The limit below which MRTP clearance was not required for investment by “laege industrial houses” was gradually raised to Rs. 100 crore. There was virtually no reform in other production sectors such as mining and agriculture.

   Imports of capital goods were made procedurally easier through licensing of imports for modernization and export industries. Intermediate imports were gradually moved from licensing to tariff protection and made available for export production at lower duty.   Tax rates declined slowly from the absurd highs they had reached in 1970s e.g. 100% marginal rate on income from assets, inclusive of wealth tax) and modified value-added tax (MODVAT) credit was introduced into the excise tax.

The control regime, however, continued to be extended in exchange management and import tariffs continued to rise.  The fiscal deficit also expanded from around 6% in the early 1980s to 9% in 1991 while the revenue surplus became a deficit of 4% over the same period. This was one of the reasons for the Balance of Payments crisis in 1990-1991 that concluded this phase of economic development. By 1991-92 the share of the Public sector in total GDP had risen to 25.9% from 22.1% in 1979-80. The public sector share of Gross Capital Formation was still high at 38.4% of total [Virmani (2004)].[i]    Leaving aside small scale sectors like Agriculture, Trade, Hotels and Restaurants and unregistered manufacturing the presence of Government was much higher.  Government thus still controlled the commanding heights of the economy besides retaining much of the institutional structure of the stifling LPQ Raj

Conclusion

      The LPQ raj started to change during 1980s and its enforcement slackened due to deterioration in governance.  Though individual policy reforms were incremental (‘tinkeization’), remaining controls and restrictions started to be evaded thus resulting in greater de-facto de-control.  They were also politically credible signals of the intent to reform failed policies. This had an impact on the investment environment leading to more private investment and a shift from building of structures towards machinery and equipment. The opening of the economy to capital goods imports reduced their relative price and magnified the impact on investment efficiency. An increase in the fiscal deficit, stimulated government consumption and raised production in the presence of an output gap.  Consequently the massive gap between the welfare of the average Indian and that of the average World citizen began to close for the first time in modern Indian history.

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[i] Arvind Virmani, “India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth,” Working Paper No. 122, ICRIER, February 2004. http://www.icrier.org/page.asp?MenuID=24&SubCatId=175&SubSubCatId=233 and

Arvind Virmani, “Sources of India’s Economic Growth: Trends in Total Factor Productivity,” Working Paper No. 131, ICRIER, May 2004. http://www.icrier.org/page.asp?MenuID=24&SubCatId=175&SubSubCatId=233.

Nehru-Indira Socialist Economics Failed

Introduction

    How can we judge the performance of the Nehru-Indira socialist, mixed economy that prevailed from 1950 to 1979? This approach is also characterized as the “License Quota Permit (LPQ) Raj.” First note that Shri Jawaharlal Nehru(JN) was PM from 1947 to his death in May 1964, while Mrs. Indira Gandhi (IG1) was PM from January 1966 to March 1977.  Thus father and daughter led the country for 25 out of the 30 years. Though there were other PMs in 1966-67 (Shastri) and 1977-9 (Morarji, Charan Singh) they didn’t have time to change the fundamental development approach.  The reason for using a cut-off date of 1979 is because the Indira Gandhi (IG2) that returned as PM for a second tenure in 1980, initiated a clear reversal of her own failed policies of the Socialist Era.

Methodology & Benchmark

     Next we need a performance measure and a comparator. Growth and Poverty reduction have often been used (including by the author) to compare performance across time periods.   But in this note we use a much more effective summary measure of Welfare, the per capita GDP at purchasing power parity, to show how the average Indian fared relative to the rest of the World. This helps us to compare the effectiveness of the Nehru-Indira socialist development strategy relative to the effectiveness of development strategies prevailing in the rest of the World during the same period.  

Many writers argue that Socialist policies were fine as growth was faster than under colonial rule. The problem is that the whole world did better after 1950, so the fact that India also did better tells nothing about the effectiveness of our policies compared to alternatives that were not only available but were actually adopted in other countries.  Other writers take specific countries such as S. Korea and argue that we performed abysmally relative to them. Though this is true it is subject to criticism of selection bias - picking the best performing countries as comparators would obviously make India look bad! Such criticism cannot be leveled when the comparator is the whole world.  A development model that leaves the relative welfare of the average Indian worse off than that of the average World inhabitant surely needs to be ostracized (not praised, as it still often is in India)!

Results

   So how did the JN-IG1 socialist approach fare? In 1950 the welfare of the average Indian was 29% of that of the average World inhabitant.  By 1979 it had been reduced to 20% (1/5^th) of that of the average world citizen.  This means that the rest of the World on average was progressing faster than India; Not just S. Korea, not just E & SE Asia, but Africa, Latin America and the developed countries (all) taken together!  During PM Nehru’s tenure, India’s per capita GDP at PPP as a proportion of average world per capita GDP at PPP, was reduced by 3 per cent points ( or -11%).  It declined further during the 1965 war and was 23% in 1966 at the start of Indira Gandhi’s 1^st spell as PM. During this first  tenure of PM Indira Gandhi (IG1) the welfare of the average Indian relative to that of the average World inhabitant declined by 2 per cent points (-8%) to 21% in 1976. It was at the same relative level in 1980.

Per capita income growth data from a different source confirms that Indian economic growth was slower than that of the rest of the World.  Between 1960 and 1979 India’s per capita GDP grew at an average rate of 1.1 per cent per annum compared to an average growth of per capita World GDP of 2.7 per cent per annum.  Thus the average Indian’s per capita income was falling behind the World by 1.6 per cent per year during this period.

Winds of Change

The Janata government formed in 1977 with Shri Morarji Desai as PM did try to change the direction of economic policy. It appointed a “Committee on controls and subsidies (Dagli),” and the “Alexander Committee on Import-Export Policy,” to analyze the LPQ Raj and suggest a new approach.  I still remember that my first foray into practical policy advise was to give a memorandum to the Dagli committee arguing that tax policy was more efficient than ‘controls’ in achieving desired objective and recommending industrial decontrol and to depose before P C Alexander on import decontrol. The Morarji government fell before the Dagli or Alexander committee recommendations could be implemented.  The Charan Singh government that replaced it barely had time to settle down before it fell in 1979.  It was only after the arrival of the second Indira Gandhi (IG2) government in 1980 that import decontrol started in earnest with surprisingly positive results.

Lessons

The Nehru-Indira version of socialism was a failure compared to other market based models being used in other parts of the World after World War II.  The main negative elements of this approach were:

(1) Nationalization of large industry and financial institutions, their consequent monopolization & suppression of competition. (2) Suppression of private entrepreneurship (including non-profits)  through oppressive controls on every sphere of economic activity and their conversions into “rent seekers”.  (3) Obsession with heavy industry to the detriment of both labor intensive light industry (rendered uncompetitive through rigid labor laws) and of agriculture. (4) Gross neglect of basic education and literacy(3 R s). (5) Creation of a large, unspecialized, overextended and oppressive bureaucracy that behaved like the inheritor of the colonial/princely rulers.   

It was only with the gradual abandonment of this model by one of its architects (IG2) that Indian growth accelerated and the Welfare gap between Indians and the rest of the World started closing.

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A version of this article appeared on the Editorial page of the Times of India on November 21, 2013, under the title, “The God That Failed: Nehru-Gandhi socialist Model placed India in precipitous decline relative to the World.” 
 http://timesofindia.indiatimes.com/home/opinion/edit-page/The-god-that-failed-Nehru-Indira-socialist-model-placed-India-in-precipitous-decline-relative-to-the-world/articleshow/26112532.cms